Ops Returns Tough, S&P Analyst Declares

Cable operators that have paid the going rate for systemsin the past year may have a rough time justifying the cost of growth, a Standard &Poor's Corp. analyst said last week.

S&P managing director Richard Siderman said that giventhe average price for a cable system today -- about $4,500 per subscriber -- cableoperators will have to generate about $100 per month in revenue from virtually all oftheir subscribers in order to realize a sufficient return on their investment.

Siderman, speaking at S&P's "Telecommunications& Cable Industry" seminar, said that in order to realize a conservative 11percent return on investment, the acquiring company will have to pare down the cost of itspurchase to about nine times cash flow.

Given that benchmark, the company would have to realize$500 in cash flow per year, per customer, Siderman said. At a profit margin of 42 percent,this means each subscriber would have to generate $1,190 in revenue per year, or about$100 each month.

"Contrast that with the typical cable subscriber, whois paying about $40 per month, and cable operators are going to have to double or morethan double monthly revenue," Siderman said. "That is a formidablechallenge."

But not an impossible one, he added.

Siderman classified cable subscribers in three categories:"stickers," or customers who are going to stay with their $45-per-month basicservices and resist purchasing any new cable products; "upgraders," who willtake an additional $20 per month in new services, be it either a digital tier oradditional pay-per-view services; and "takers," those customers who will buyjust about everything the cable company has to offer.

Siderman mapped out three scenarios: one where 100 percentof subscribers are takers, the second where revenue is split equally among the threecategories and the third where 50 percent of the customer base are stickers, 30 percentare upgraders and 20 percent are takers.

In the first scenario, cash-flow multiples after three orfour years are nine times; in the second, the multiple rises to 13 times; and in the third-- which, he said, was the most likely configuration -- the multiple is 14.7 times.

Siderman added that his three scenarios do not take intoaccount organic growth in basic services and rate increases. However, they also don'tinclude the significant capital expenditures needed to upgrade cable plant to be able tooffer additional services.

"The purpose of this is not to suggest that it can'tbe done," Siderman said. "The purpose of this is just to suggest that torationalize, or to make these investments at $4,500 per sub or $5,300 per sub, means thatthese operators clearly are looking at offering a whole bunch of services that really arenot out there now, and that these customers are going to be more than just cable customerstaking a pay service. It's really a sea change in the customer base."

Despite the challenge of rationalizing acquisitions, cablecompanies are expected to continue to consolidate, Siderman said, although he expects manyof the deals to involve system swaps instead of outright purchases.

"There's a lot of potential over the next two or threeyears to see systems traded," he said. "Clearly, we are going to see a lot ofactivity there, and I would expect to see trades and companies trying to get bigger piecesof clusters, maybe selling off some systems that are better managed by smalleroperators."

Siderman also foresees a moderate increase in core servicesbut more growth in advanced services.

Despite the uncertainties, he also expects a moderateimprovement in the credit markets for cable companies, based on the potential for newservices and the growing trend by some cable companies -- like Adelphia CommunicationsCorp. and Charter Communications -- to offset some of the costs of acquisitions by issuingequity.

"These are moderating factors to the prices beingpaid," he said. "Cable modems are probably more popular and being taken at ahigher rate than even the most optimistic cable company thought two or three years ago,with some nodes getting 20 percent and 30 percent penetration. Digital offerings are beingrolled out -- the more choices you give people, the more they will take."